Professional Documents
Culture Documents
3Q 2013
the art
of investing
14 Hedge Funds Seek Critical Mass While 41 Board Governance—Ever Raising the Bar
Sustaining Profitable Margins Important concerns and some best practices
for board members at U.S. mutual funds are
The highlights of a survey of 174 hedge fund
presented by Rachel Sykes.
clients are examined by Kumar Panja and
John Cotronis.
44 The Securities Lending Industry in
18 Maturing Market, Emerging Opportunity— 2013—Turning Crisis into Opportunity
the Transformation of Asia Paul Wilson sees greater opportunities and
cites highlights from J.P. Morgan’s Securities
The opportunities for asset management in Asia,
Lending Forum.
say John Murphy and Andrew Lawson,
are quite remarkable.
48 Notes from J.P. Morgan’s Pension Blog
24 Perspectives on the Economic Evolution In his column, Benjie Fraser shares
the unconventional views of guest writer
of Brazil Adjiedj Bakas on longevity.
Cedrick Reynolds examines key data to illustrate
the country’s current economic picture and
factors affecting investor strategies.
IDEAS IN ACTION
49 Complete Collateral Portfolio Solutions
50 Finish Line in Sight—Achieving the Target End State for U.S. Tri-Party Repo Market Reforms
51 New Industry Recommendations to Margin Forwarding-Settling Agency MBS Transactions in the U.S.
52 The Pathway from Frontier to Emerging: Middle East Markets
FIG–02
14%
ANNUALIZED RETURNS
10.96 %
11.16 %
10.64 %
9.70 %
9.80 %
12%
9.08 %
8.89 %
8.70 %
8.22 %
8.18%
10%
7.24%
7.25 %
7.10 %
6.57 %
6.48 %
6.34%
5.96 %
5.92 %
8%
5.49 %
5.63 %
5.32%
5.08%
5.18 %
4.79%
4.47%
6%
4%
2%
0
0
0
0
Barclays U.S. MSCI Mei Moses® S&P FTSE NAREIT S&P GSCI
Aggregate EAFE Index World All 500 Index All Equity
Art Index REIT Index
FIG–03
S&P 500 MSCI EAFE FTSE NAREIT Barclays S&P GSCI Mei Moses
All Equity REIT Aggregate World All Art
FTSE NAREIT
All Equity REIT 0.4909 0.4898 1.0000 – – –
Mei Moses
World All Art 0.0270 0.0882 -0.1365 -0.0902 0.2440 1.0000
Selectivity a factor such as economic growth and inflation, has greatly outperformed the Mei
but also micro-factors unique to the Moses World Impressionist Modern
It is worth noting that certain art market, such as global interest in Index, particularly over the last 10
genres do better than others for a years. As with other asset classes,
certain genres and changes in trends,
number of reasons. Art can be an investors should look to diversify their
tastes and culture.
unpredictable investment in which holdings to manage their exposure
returns may be heavily influenced by As figure 4 shows, the Mei Moses across different genres, artists or types
not only a number of macro-factors, World Post-War Contemporary Index of work.
FIG–04
600%
CUMMULATIVE RETURN
500%
400%
300%
200%
100%
0
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Mei Moses World Post-War Contemporary Index Mei Moses World Impressionist Modern Index
FIG–05
Sources: U.S. Equities—S&P 500 Index, Commodities—S&P GSCI, Art—Mei Moses World All Art Index, U.S. Bonds—
Barclays U.S. Aggregate. High and low inflation distinction is relative to median CPI-U (source: BLS).
23%
25% 25%
18%
18%
20% 20%
13%
15% 15%
10% 10%
5%
-15%
2%
-2%
5% 5%
0% 0%
-5% -5%
-10% -10%
-15% -15%
25% 25%
17 %
20% 20%
12%
9%
15% 15%
7%
6%
4%
10% 10%
3%
5% 5%
0% 0%
As emerging markets become a steep decline in the art market in the crashed. In theory, a more global
wealthier, the art market is likely to early 1990s was in part attributable to market is more resilient. As figure 6
continue to be comprised of a much the decline in the Japanese economy. shows, art prices took almost a decade
more diverse set of art buyers. This is During the highly inflationary 1980s, to recover from that slump when
generally good news. When investors Japanese investors were investing the market was more concentrated
are concentrated in one geographic heavily in art. As the Japanese real geographically in a small number of
region, the art market as a whole estate market started to collapse in the wealthy countries, while the downturn
is very sensitive to that region’s early 1990s, investors there pulled back during 2008 was short-lived in
economic environment. For example, and many segments of the art market comparison.
About 2 years
500% to recover
CUMMULATIVE RETURN
22%
400%
drop
300%
150%
100%
50%
0
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
1 www.tefaf.com.
2 www.capgemini.com.
3 In the 2011 RBC/Capgemini Global Wealth
Management Financial Advisor Survey, 42
percent of advisors believe their HNW clients
invest in art primarily for its potential to gain
in value.
4 Patrick Mathurin, ”Gold feels weight of
Paulson Curse,” Financial Times, 8 January,
2012, www.ft.com.
5 Orley Ashenfelter and Kathryn Graddy,
“Auctions and the Price of Art,” Journal of
Economic Literature, Volume 41, Issue 3,
September 2003, www.aeaweb.org/jel.
6 Used with permission; more information
about the Mei Moses Art Indexes may be
found at www.artasanasset.com.
7 2012 Russell Investments’ global survey of
144 large institutions, cited by Mark Cobley
in “Pension Funds Embrace Alternatives,”
www.efinancialnews.com.
27%
63%
70%
50%
60% Cash
50%
40%
19%
30%
20%
10%
overnight repo to limit their risks for securities lending programs, A small portion of U.S. institutional
whether they are providing cash there is a similar conversation lenders see demands for cash in other
against government bond, agency, on risk versus reward regarding areas and believe that non-cash will be
equity or corporate bond repo. acceptance of securities other than the most viable collateral option for
However, very low returns and a government bonds as collateral. borrowers going forward. This is not
periodic or potentially permanent Government bonds are undoubtedly entirely welcome as most U.S. funds
lack of liquidity mean that some preferred but investors recognize either do not accept non-cash or do
institutions are looking at longer term the growing scarcity of those assets not like to advertise the fact. Several
repo options. in the market. The alternatives large funds that we interviewed said
are to accept a planned decrease that they had not been asked to accept
in securities lending revenues or non-cash for loans lately, and U.S.
Institutional investors on to take other asset classes, with borrowers were cash-rich in the first
non-cash collateral higher margin levels. For example, half of 2013. However, the expectation
Among non-U.S. investors where equities may be accepted with up to from our interviews is that non-cash
non-cash collateral is the norm 110 percent collateralization. use will grow as the U.S. economy
enjoys a stronger economic recovery.
78%
80%
Mutual funds and insurance
70%
companies on cash collateral
60%
In Finadium’s August 2013 survey of 50%
the largest mutual funds and insurance 40%
companies in securities lending, we
19%
30%
saw little change in cash collateral
11%
management practices since 2011.2 20%
0%
managed their own collateral internally 0
while another 11 percent used an
Internal Unrelated custodian Affiliated custodian Unrelated agent
affiliated custodian, and several funds
Note: multiple choice question.
had more than one cash reinvestment
vehicle (see figure 3). Only 19 percent of
firms chose to have their cash collateral FIG–04
managed by an unaffiliated custodian.
Securities Lending Cash Collateral Investments of Asset Managers (%)
We saw consistent interest in
overnight repo only as a cash collateral Source: Finadium
40
At the same time, 68 percent of our
20
sample used a money market fund or
separately managed account including 0
Rapidly developing cycles of obstacles Now in its third year, the survey Fund strategies and
and opportunities continue to play examines diverse elements of hedge
asset allocation
a dynamic role in the operational fund structures and strategies. Key
direction of hedge funds. J.P. Morgan’s findings include the growth of
Prime Brokerage Consulting Group separately managed accounts, changes
Key Findings
recently completed analysis of a in staffing and the adjustment of Strategies employed by hedge funds
four-month survey of hedge fund performance fees, among others. remained largely unchanged from
clients, aggregating key insights “With institutional investors pushing 2010 through 2012 with the notable
concerning the industry’s expansion back on fees, we expected to find that exception of credit/distressed.
and factors influencing growth. “Our smaller to mid-sized hedge funds Among those strategies, allocations to
clients’ feedback conveys some of the would be reducing headcount,” said commodities have decreased sharply.
response to regulatory change and John Cotronis, NA head of Prime
toward new efficiency trends,” says Brokerage Consulting. “Instead we Overall, the strategies employed by
Kumar Panja, Global head of Prime found that they were adding staff, hedge fund respondents were fairly
Brokerage Consulting. “The cumulative holding the line on administrative fees consistent from 2010 through 2012
data we’ve built provides some unique and compromising largely on their with the exception of credit/distressed,
insights into directional shifts over performance incentives.” which declined from 55 percent
time as well as certain continuing in 2012 to 48 percent in 2012. This
patterns for the industry as a whole.” decrease may reflect what hedge funds
view as a diminishing opportunity set
in the credit arena since little room
may be left for price appreciation.
FIG–01 FIG–02
Assets Under Management for 174 Funds Evolution in AUM Allocated to Strategies
Source: J.P. Morgan’s 2012 Prime Brokerage Hedge Fund Survey Source: J.P. Morgan’s 2012 Prime Brokerage
Hedge Fund Survey
100%
38%
80% 100%
27%
60%
36%
34%
31%
13%
22%
14%
25%
21%
40%
19%
19%
16%
16%
14%
13%
11%
10%
11%
9%
8%
6%
20%
5%
0 0
47%
38%
90%
82%
You Raising Capital? 100%
Financing sources
39%
37%
Source: J.P. Morgan’s 2012 Prime Brokerage
50%
Hedge Fund Survey
Within different peer groups in the
86%
80%
41%
The survey measured the types of asset What Percent of your AUM is Financed by the Following Sources?
classes that respondents use for trading Source: J.P. Morgan’s 2012 Prime Brokerage Hedge Fund Survey
and investments, ranging from equities
to FX and ABS. Notable changes 100%
included CFDs, which shot up from
80%
31 percent in 2011 to 48 percent last
60%
year; commodities, which fell by two
31%
30%
30%
10%
12%
12%
10%
5%
5%
5%
4%
4%
20%
1%
2%
3%
2%
0%
0%
+687%
a series of special reports regarding the 800%
asset management industry in Asia.] 700%
+402%
Asset managers must rapidly evolve
+369%
500%
their strategies to address wealth
400%
accumulation and an amassing pool
of investible assets within the region, 300%
combined with the emergence of 200%
retail investors with diverse needs. In
100%
parallel, the long-term move toward
integrating Asia’s markets, with an 0
Moving offshore onshore Asset managers respond the operating context of the offshore
wealth centers.19 Whether to establish
In parallel, Singapore and Hong Kong Key to the maturation process within a local presence through branches or
are emerging as hubs for offshore Asia is the ability of asset managers partnerships and which products and
wealth management within the to satisfy investor demand amid services to provide are cited among
region as Asia’s HNWIs increasingly changing dynamics. Toward this end, the critical decisions.
seek offshore solutions closer to they are shifting their approaches
home than traditional centers, within Asia’s diverse context— Offshore asset managers with a
such as Switzerland.15 Research including fine-tuning their strategies mass retail focus often sell products
by WealthInsight indicates that to service changing client needs. through institutions or wholesale
Singapore will surpass Switzerland distributors in and around the
Depending on their focus, they are region to retail investors, given that
as the largest offshore wealth center adopting a range of strategies. For distribution is challenging in countries
as measured by AUM by 2020.16
those foreign players operating in where distribution is captive or there
Singapore’s AUM has grown to
the offshore wealth management are dominant players, among other
US$550 billion from US$50 billion hubs, to compete against entrenched factors. Those engaged in onshore
in 2000, with about US$450 million local firms and grow profitably in the asset management for retail investors
attributed to offshore wealth.17 Hong midst of high operating costs, it is are preoccupied with where to launch
Kong is also a recipient of funds imperative to properly target AUM local domiciled products in and
transplanted from Europe’s historical and to understand the cultural and around Asia and what, when and how
private banking locations.18 behavioral nuances of investors and to do this.
Cedrick Reynolds
Executive Director
Latin America
Inflation and real rates of return target (6.7 percent through June of this levels had become intolerable and the
year), and this limits the government’s government began to reverse course
Since the adoption of the Real Plan ability to use its full panoply of tools and raise interest rates. In 1Q13, the
and the introduction of the Real to stimulate the economy. spread between SELIC and actual
in 1994, inflation management has inflation declined to its lowest level
been a central component of Brazil’s Beginning in 3Q11, Brazil began
since the introduction of the Real
economic policies. The government aggressively reducing its benchmark
(see figure 1). Declining real rates of
communicates inflation target ranges risk-free rate (SELIC) to help stimulate
return limit the government’s ability
and uses its available tools to keep economic growth. Rates decreased
to fully use the stimulus provided by
inflation within that range. The from 12.5 percent in 3Q11 to 7.25
lower interest rates. The SELIC rate
current target is 2.5 percent to 6.5 percent in 4Q12. This policy required
is currently at 8.5 percent and the
percent.1 Reported inflation rates are inflation to stay within the target
government has a stated year-end
currently beyond the upper end of the range. However by 1Q13, inflation
target of 9.25 percent to 9.5 percent.
05Q1
05Q3
06Q1
06Q3
07Q1
07Q3
08Q1
08Q3
09Q1
09Q3
10Q1
10Q3
11Q1
11Q3
12Q1
12Q3
13Q1
13Q3*
returns. Subsequent volatility
has remained high, but absolute
SELIC Inflation
returns have lagged broader
global indices. Recent interest rate
reductions and broader economic FIG–02
stimulus have not provided
Forecasts
significant lift to the Bovespa.
Historically, rising inflation has Sources: J.P. Morgan Research and Banco Central do Brasil
served as a leading indicator of
downward pressure on equity 2013 SELIC IPCA2 (JPM) IPCA (BCB)3
market valuations (see figure 4).
July 8.5 6.22 6.49
Equity market capitalization
August 9.0 6.02 6.39
remains at historically high levels,
at 54.6 as percent of GDP in 2012 September 9.0 5.92 6.22
(see figure 5 for historical data).
October 9.5 5.92 6.10
Brazil is also the world’s sixth
largest investment funds market November 9.5 5.94 6.04
with approximately $1.1 trillion of
December 9.5 5.85 5.82
assets under management.
FIG–03
32.9
43.6
13.9
82.7
17.0
15.1
29.1
5.0
213.8
17.7
22.1
14.0
12.4
19.0
11.9
14.5
28.2
1.6
145.5
13.7
18.3
11.8
11.0
17.4
11.3
14.0
26.7
0.2
113.9
11.5
15.1
10.7
1.8
12.7
11.1
11.6
18.4
-1.0
110.9
11.3
15.0
9.3
-0.4
12.5
9.7
8.3
14.3
-1.4
82.2
8.9
11.1
-3.1
-15.7
9.9
8.6
4.7
8.6
-2.2
52.1
6.2
-2.4
-6.5
-23.8
1.2
7.8
-2.6
8.4
-2.6
15.9
2.1
-6.7
-15.1
-41.2
-11.1
1.0
-18.1
7.4
-7.5
-20.3
-3.2
2006 2007 2008 2009 2010 2011 2012 1Q2013 Cum. Ann.
(’06 - ‘12)
Balanced Brazilian Equity Real Rates Nominal Rates Risk Free World Equity EMD DJ UBS Cmdty
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
support for Brazilian exports and
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
attract investment to modernize
the country’s infrastructure. The
challenge for the government will
Brazil United States EU China Japan
be controlling inflation through rate
increases that will potentially provide
FIG–06
lift to the Real while managing to an
overall need for a weaker currency to Commodity Price Data
support local industry growth. (Monthly indices based on nominal U.S. dollars, 2005=100, 1960 to present)
400
41 percent 300
100
0%
and one-third 2005 2006 2007 2008 2009 2010 2011 2012 2013
04Q1
04Q3
05Q1
06Q3
07Q1
07Q3
08Q1
09Q3
10Q1
10Q3
11Q1
12Q3
13Q1
13Q3*
government has also removed capital
inflow taxes focused on “hot money”
(defined as foreign capital chasing BRL / US$ * Projected
Diversification through and stimulate demand. Relatively have been largely invested within
high tariffs on imports put additional the country’s borders. The nearly $2
globalization
inflationary pressures on consumer trillion of capital held by Brazilian
Inasmuch as the Brazilian government goods and higher inflation will insurance companies, pension
has taken an aggressive stance to negatively impact real rates of return. funds and investment managers is
combat inflation while providing Falling commodities prices will impact minimally invested offshore. Part of
stimuli necessary to jumpstart its important agricultural and mining this is due to regulatory restrictions
economy, investors need to determine segments of the economy. Several that limit the amount that can be
whether the risk/reward profile of complex economic issues need to invested outside of the country.
a highly concentrated portfolio of be addressed and the government is Another driver is lack of experience
Brazilian assets can be justified on using its available tools to balance and unfamiliarity with structuring
a risk-adjusted basis. Key drivers of these moving parts. vehicles and strategies necessary
local economic performance and GDP Global markets and indices have in providing diversification while
growth have recently been under outperformed Brazilian equity safeguarding investments. Properly
pressure. Rising interest rates will markets in each of the previous three structured vehicles domiciled in
offset previous government efforts years. Major asset owners in Brazil jurisdictions with transparent
to inject capital into the economy have significant pools of capital that investment fund regulations allow
• Roughly 22 percent of
mineral fuels and oils exports
and 28 percent of iron and
steel exports are destined
for the U.S.
FIG–02 A FIG–02 B
Sources: Lipper LIM and PwC analysis, December 2012 Sources: Lipper LIM and PwC analysis, December 2012
72,264
17 %
530
80,000 600
NO. OF REGISTRATIONS FOR PUBLIC DISTRIBUTION
65,931
GROWTH
62,812
58,553
56,492
70,000
452
500
49,266
389
60,000
43,304
400
302
50,000
36,411
300
28,427
40,000
26,966
26,030
22,791
200
30,000
17,850
14,400
70
11,338
20,000 100
10,000 0
0
2001
2008
2010
2011
2012
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Source: PwC
9,436
10,000
7,002
ALL CROSS-BORDER FUNDS
8,000 5,521
5,210
5,006
4,918
4,345
4,217
4,110
6,000
3,331
2,761
2,417
2,409
4,000
1,946
1,840
1,277
1,214
1,221
2,000
0
DE CH AUT UK NL FR ES IT SE FL BE SIN NR DK CHI PT HK
between 2015 and when the EU can looking to strengthen their local fund Commission is aware of this issue and
get the passport. There’s going to be industry, in part because they need to considering how it can grant some
a maze of regulation which managers make their funds more competitive kind of reciprocal UCITS distribution
in the EU or outside will need help versus foreign products such as UCITS. arrangement with key Asian markets.
in interpreting. This will present Interestingly, some of them may seek In the medium to long-term, it’s
challenges and will certainly to replicate parts of the UCITS model unrealistic to think UCITS can keep
change the dynamics of the global within their own investment funds’ coming to Asia and generating billions
distribution model. regulatory framework. of euros of net sales from Asian
Moreover, with the potential of an investors into UCITS that are managed
Asian “fund passport” we’re also seeing in Europe or the U.S. if Asian funds
O’BRIEN: What impact is AIFMD
the emergence of bilateral reciprocal are excluded from the European
likely to have outside of Europe and
agreements among Asian countries investment market as a result of
what is the future of UCITS outside
to sell Asian-domiciled funds. These AIFMD. This is a very important point.
of Europe?
arrangements are also replicating O’CALLAGHAN: It’s difficult to assess
EVANS: AIFMD may pose an parts of the investor protection and what impact AIFMD will have outside
underlying challenge to UCITS in diversification rules that UCITS offer of Europe. We’ve seen redomiciliation
some regions, especially in Asia if the and potentially pose a long-term threat of some funds from non-EU domiciles
AIFMD brand develops and becomes to the UCITS model. to Ireland and Luxembourg. The
an attractive proposition for both asset Another potential challenge to mutual recognition agreement
managers and investors who may UCITS distribution into Asia is the between Hong Kong and China is very
otherwise have contemplated a UCITS. growing discussion around mutual interesting. UCITS currently account
Moreover, the tremendous success of recognition coming from a number for over 80 percent of the funds sold in
UCITS in Asia could also be a challenge of Asian countries. There’s increasing Hong Kong. In the future we’re likely
to its future market penetration and pressure on the EU to look at some to see increased demand for both
long-term sales success. We know sort of reciprocal arrangements UCITS and Hong Kong-domiciled
that a number of Asian countries are with Asian regulators. The EU unit trusts.
Retrocessions
O’BRIEN: The introduction of the CHRISTIAN: It’s possibly too early changes in that UK financial
Retail Distribution Review (RDR) in to tell. The Retail Distribution advisors can no longer get paid or
the UK also requires fund managers Review has been hailed as the biggest earn commission from the product
to adjust their sales channels and shake-up within the UK financial manufacturer for the sales of third-
products for that region but is likely to services’ history because it affects party or proprietary products.
spread across Europe. Is this a positive remuneration—how distributors, Financial advisors now have to charge
development for investor transparency advisers, in particular, get paid. The their end consumers, which means
or a threat to the open architecture? RDR regime has brought massive that the best-of-breed products offered
Alessandra Tocco
Global Head
of Capital Introduction
Defined Benefit
Plans and
Hedge Funds:
Enhancing Returns
and Managing
Volatility
FIG–02
97Dec
98Dec
99Dec
00Dec
01Dec
02Dec
03Dec
04Dec
05Dec
06Dec
07Dec
08Dec
09Dec
10Dec
11Dec
12Dec
Driven (%)
Event
Value (%)
Relative
Macro (%)
Global
500 (%)
S&P
FIG–06
Source: Hedge Fund Research, Bloomberg
Hedge Fund and Traditional Asset Allocation Performance, 1997 to 2012
160
Sources: Hedge Fund Research, Bloomberg
Returns
Annualized
150
130
300
120
250
Returns
Cumulative
100
150
90
100
80
50
96Dec
08Dec 98Dec 00Dec
09Dec 02Dec 04Dec
10Dec 06Dec 11Dec
08Dec 10Dec 12Dec
12Dec
FIG–05
(%)
Bonds
(%)
S&P 500
(%)
MSCI AC
(%)
Commodities
FIG–07
09Jun
09Dec
10Jun
10Dec
11Jun
11Dec
12Jun
12Dec
6.0%
Board Governance—
Ever Raising the Bar
Board members at U.S. mutual
fund companies may be feeling
under pressure these days. With
recent high-profile SEC enforcement
actions and the resulting news
headlines, fund directors have come
under increasing scrutiny. There is
interest from regulators for greater
clarity on valuation, disclosure of
fees, adherence to policies and
procedures, and concerns about
delegation of duties.
FIG–01
Morgan Keegan:4
Eight former fund directors of
Morgan Keegan were charged by
the SEC on a number of valuation-
related charges in December 2012. Board composition—Investors Diligent compliance practices
It was alleged that the board are seeking qualified, independent should be visible in all parts of the
delegated the responsibility for directors with minimal conflicts of organization and demonstrate a
determining valuations without interest. Boards are responsible for a clear understanding of client needs.
providing direction or retaining broad range of functions, including Regulators have clearly documented
oversight. It was further alleged the assessment of fund manager their priorities, and funds should be
that the directors made no efforts performance, review of manager prepared to meet them.
to understand the fair value contracts, oversight of manager
process and relied on a valuation adherence to fund registration and
committee and the firm’s fund investment guidelines, and reviews of
accountants. prospectus documentation, regulatory
filings and compliance results. The
Yorkville Advisors:5 composition of a board should be 1 Charles D. Ellis, CFA, Financial Analysts Journal,
In October 2012, hedge fund reviewed, and it should be considered vol. 68, no.3, “Investment Management Fees
adviser Yorkville Advisors was if it is appropriate to enhance the Are (Much) Higher Than You Think,”
charged with fraud related to diversity of experience represented in May/June 2012, www.cfainstitute.org.
suspicious fund performance. its composition. 2 Richard B. Evans and Rüdiger Fahlenbrach,
The regulator alleged that the CFA Digest, vol. 43, no. 2, “Institutional
Transparency of fees—Investors Investors and Mutual Fund Governance:
hedge fund misrepresented the
should be provided with access to Evidence from Retail–Institutional Fund Twins,”
characteristics of the fund and its
simple, clear data regarding all fees May 2013, www.cfainstitute.org.
related valuation methodology and
for which they may be responsible. 3 National Examination Program,
charged excessive fees based on
Investors also should feel confident Office of Compliance Inspections and
over-inflated performance returns,
that they are paying a reasonable fee Examinations, “Examination Priorities for
among other charges.
for the benefits received in terms of 2013,” February 21, 2013, page 4, www.sec.gov.
Oppenheimer:6 investment returns. Ensure that fees 4 United States of America Before the Securities
On March 11, 2013, the SEC found are in keeping with current standards and Exchange Commission In the matter of
and are clearly communicated. J. Kenneth Alderman, CPA; Jack R. Blair;
that Oppenheimer provided
Investors should be permitted to see Albert C. Johnson, CPA; James Stillman R.
misleading valuation and McFadden; Allen B. Morgan Jr.; W. Randall
performance information. The the impact of these fees on their total
Pittman, CPA; Mary S. Stone, CPA; and Archie
actual valuation practices were not absolute and relative returns to allow W. Willis III, respondents, Release No. 30300/
consistent with the stated policies, for fair comparisons. The pay structure December 10, 2012, www.sec.gov.
resulting in overstated performance should be disclosed for both board 5 United States District Court Southern District of
results. The regulator also found members and investment managers, New York Securities and Exchange Commission,
that the policies and procedures demonstrating the performance-based Plaintiff, against Yorkville Advisors, LLC, Mark
were not reasonably designed to components and/or incentives. Angelo, and Edward Schinik, www.sec.gov.
ensure valuations were presented In conclusion, it seems reasonable for 6 United States of America Before the
as stated. The firm settled with boards to expect continued attention Securities and Exchange Commission In the
the regulator for $2,800,000 and matter of Oppenheimer Asset Management
from regulators. As such, policies and
was similarly penalized by the and Oppenheimer Alternative Investment
procedures should be thoughtfully Management, respondents, March 11, 2013,
Commonwealth of Massachusetts reviewed and validated regularly. www.sec.gov.
for approximately $130,000.
In 1959 John F. Kennedy said, For the securities lending business, disappeared, others have survived,
“In the Chinese language, both aspects of that statement are recalibrated their business models and
significant. Market participants need even thrived.
the word ‘crisis’ is composed of to be attuned to the challenges and These themes are under constant
two characters, one representing risks to their activities. However, they scrutiny within organisations, as the
danger and the other, opportunity.” 1 also need to be able to navigate these regulatory environment relating to the
to exploit the opportunities that exist securities lending business continues
in a climate that might otherwise only to develop while multiple jurisdictions
be viewed as negative. The financial and regulators propose and implement
crisis of 2008 and its immediate new regulations. The potential impact
aftermath are behind us, and while of these regulatory measures on
some participants have fallen by the securities lending business is
the wayside or have completely illustrated in figure 1.
ESMA Guidelines
HIGH IMPACT
on UCITS and ETFs FTT
Shadow
Banking
UCITS V UCITS VI
EU S/S
MiFID
Basel 3/CRD 4
IMMINENT
FUTURE
OCC Short Term Dodd-Frank
CSD Regs Investment AIFMD
FATCA Fund Rule
FSA CASS
LOW IMPACT
Rule Updates
10/2010
01/2011
04/2011
07/2011
10/2011
01/2012
04/2012
07/2012
10/2012
01/2013
04/2013
10/2010
01/2011
04/2011
07/2011
10/2011
01/2012
04/2012
07/2012
10/2012
01/2013
04/2013
Forever Young!
A clear view that cuts through the complexity Then, sophisticated optimization algorithms combine with
rigorous eligibility testing to recommend scenarios for
Global regulations and prudent business practices are consideration. Current advanced waterfall algorithms will
driving buy- and sell-side institutions to deploy more be supplemented with a linear, multi-factor optimization
collateral, against more counterparties and transactions, algorithm, creating greater flexibility in defining conditions
than ever before. for collateral usage and identifying opportunities.
Increased demand for collateral, plus a heightened focus Optimally deploying collateral will reduce the need for, and
on quality and liquidity, challenge institutions to fully cost of, transformation services. Should a mismatch occur,
understand the assets they hold, how to best leverage them, collateral upgrade trades or other time-tested financing and
and the true cost of collateral. liquidity strategies are available from J.P. Morgan.
J.P. Morgan offers new ways to understand and assess
collateral needs, including advanced tools and analytics Data-driven decisions
to support informed decision-making and help reduce
financing costs. Holistically managing collateral extends beyond the efficient
deployment of collateral to understanding its true cost.
Increasingly, clients are factoring the cost of collateral into
Global view of assets and obligations the cost of the trade.
First, institutions must fully understand the assets available J.P. Morgan’s advanced data and analytics support informed
for use and the obligations that need to be collateralized. decision-making. What will be the margin impact of an
This view can be restricted when assets are held at multiple incremental trade? Which futures commission merchant
custodians and obligations are due to multiple clearing/ should I use? Can I gain portfolio margining benefits? Does
prime brokers or central clearinghouses. Clients who a trade give me an asset that’s valuable as collateral? Does
manage collateral against multiple initiating transactions or the collateral required to support a trade affect its value?
in multiple regions face an even more fragmented view.
J.P. Morgan’s unique global solution is clearing broker- Collateral portfolio management
and custodian-agnostic, providing a central view Managing collateral well can positively affect the
of your assets, whether held with J.P. Morgan or institutional bottom line, particularly as central clearing
with other custodians. Similarly, transaction data is increases demand for high quality, highly liquid collateral.
sourced from your brokers, with permission, providing This is likely to limit supply and inflate costs. Concurrently,
a comprehensive view of margin requirements and a more operationally complex market model is driving a
obligations requiring collateralization. Data is synthesized shift from traditional collateral servicing models.
in the virtual global longbox.
J.P. Morgan’s integrated end-to-end solution cuts through
the complexity to help you make the most of increasingly
Collateral optimization critical collateral assets. We can help you manage trading
As demand for collateral increases, it’s critical to put the activities with a sharp eye on your collateral bottom line.
right asset in the right place at the right time, fully utilizing
your assets to reduce financing costs.
Using data in the virtual global longbox, you can model and “We believe that collateral has become so business-critical
run comprehensive projections using actual or hypothetical
portfolios to understand the impact of different decisions. that it should be treated as a new asset class,
For example, you could assess the cost of sourcing a subject to the same portfolio management and analysis
particular piece of collateral in the market or the potential as other crucial trading decisions.”
economic benefit of lending a desirable asset rather than
using it as collateral.
Mark Trivedi
Global Product Head for Collateral Management, J.P. Morgan
J.P. Morgan significantly reduced the credit extended The final steps
to dealers in its U.S. Tri-Party Repo business during the
second quarter. New tools enable dealers to process the J.P. Morgan aims to implement the last deliverables to
settlement of their repo transactions in an operationally achieve the Target End State by year end. Three linked
efficient manner, reducing the need for clearing bank credit initiatives will virtually eliminate J.P. Morgan’s extension of
extension by: uncommitted credit for tri-party:
• Eliminating the unwind for trades that roll. Maturing • Rolling settlement will allow dealers to initiate the
trades that are replaced with a new trade with the same maturation and settlement process of repos after 3:30
profile (same counterparty, terms and amount) no longer p.m., expediting the return of cash for maturing trades.
require credit. By settling rolling trades throughout the • Simultaneous exchange of cash and collateral will keep
day using J.P. Morgan’s technology, dealers can focus on transactions fully collateralized.
maturing other trades after 3:30 p.m.
• A new secured committed credit advance facility will
• Netting General Collateral Finance (GCF) repo allow dealers to obtain secured financing from
transactions. These transactions had previously J.P. Morgan at competitive rates, up to pre-negotiated
unwound on a gross basis, requiring an extension of limits, to cover short-term financing shortfalls.
credit for the full amount until new funding was in place.
Now, maturing and new trades are netted, reducing credit J.P. Morgan continues to work closely with dealers and
requirements to correspond to the difference between the cash investors to prepare them for upcoming deliverables
maturing trade and anticipated new funding. and changes. Once the Target End State is met, we will
continue to introduce additional GCF repo functionality and
Together, these changes have reduced the need for other capabilities to support our clients’ need for complete
intraday credit by 70 percent, or hundreds of billions of collateral portfolio solutions.
dollars. Eliminating the uncommitted credit extended by
the clearing banks is a key goal of the Federal Reserve
Bank of New York-sponsored Tri-Party Repo Infrastructure
Reform Task Force.
Late in 2012, the Federal Reserve Bank of New York- Effectively managing new collateral and margin
sponsored Treasury Market Practices Group (TMPG)
requirements
recommended new margining practices, similar to those
used for OTC derivatives trades, for forward-settling U.S. With US$750 billion to $1.5 trillion of unsettled transactions
agency mortgage-backed securities transactions (including on a daily basis and scores of active dealers, the size and
TBA bonds). fragmentation of the MBS market makes the year-end
The TMPG recommends that counterparties: timeframe challenging—even for market participants who
already collateralize other transactions. In preparation
• Regularly exchange two-way variation margin in an for year-end, clients will need to agree on terms, finalize
amount equal to the mark-to-market change of the net agreements, and prepare systems to handle daily variation
value of the unsettled forward transaction (for TBA margin flows across custodians and CSDs. On an ongoing
bonds with a trade/contractual settlement date difference basis, before moving collateral, participants will need
of more than one day). to reconcile positions, manage haircuts, asset allocation
• Secure written agreement to terms, using documentation preferences, eligibility schedules and concentration limits.
such as the Master Securities Forward Transaction In today’s collateral environment, simply meeting a
Agreement. Such terms include collateral eligibility, margin call is no longer enough. As collateral becomes an
valuation of exposures and collateral, timing and increasingly valuable asset, institutions must be able to
frequency of margin calls, thresholds, minimum transfer rapidly assess over- or under-collateralization and optimize
amounts and liquidation procedures. the use of their collateral portfolio. As one of the world’s
Originally recommended for June 2013, the TMPG leading collateral agents, J.P. Morgan supports Agency MBS
recognized operational and legal complexities and now and TBA Bond transactions as part of its comprehensive
recommends “substantially complete” implementation by collateral portfolio solution.
year-end. Margining forward-settling agency MBS exposures
can help reduce the credit risk inherent to forward-settling
trades, enhance financial system stability, and support
market function during periods of market stress.
Editor’s note: this article references detail from the Treasury Market Practices Group’s “Margining in Agency MBS Trading,” November 14, 2012,
and “TMPG Releases Updates to Agency MBS Margining Recommendation,” March 27, 2013, www.newyorkfed.org/tmpg.
Americas Asia-Pacific
Chris Lynch Laurence Bailey
Managing Director Managing Director
+1 212-552-2938 +852 2800-1800
chris.e.lynch@jpmorgan.com laurence.bailey@jpmorgan.com
Design Team
Prasad Apte
Gino Paulo Bulanhagui
Robert Chasolen
Preeti Chawla
Azeem Hussain
©2013 JPMorgan Chase & Co. All rights reserved.
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